Fighting Tax Competition in the Presence of Unemployment: Complete versus Partial Tax Coordination

We analyze the welfare consequences of tax coordination agreements that cover taxes on mobile capital and on immobile labor. In doing so, we take into account two important institutional details. First, we incorporate decentralized wage bargaining, giving rise to involuntary unemployment. Second, we distinguish between complete tax coordination, which effectively covers both tax instruments, and the more plausible case of partial tax coordination, where one tax is marginally increased by all countries, while the other tax rate can still be freely chosen by all countries. It is shown that complete tax coordination remains welfare-enhancing in the presence of unemployment. In contrast, for partial tax coordination, the welfare effect becomes ambiguous and is different to the case of competitive labor markets.